Exploring Model-Based Approaches to Contagion in Global Financial Markets: A Survey

Abstract

The intensification of economic globalization has facilitated deeper cross-country linkages, serving as conduits through which country-specific shocks can transmit to affect financial conditions and macroeconomic variables across borders. This phenomenon has gained increased attention since the financial crises of the 1990s, with crisis propagation becoming a contentious issue in international finance. In the wake of the global financial crisis of the late 2000s, the concept of contagion has garnered considerable interest from both academia and policymakers alike. This survey aims to explore recent model-based approaches to understanding contagion in the realm of international finance. By examining the evolving literature on contagion, the survey seeks to shed light on the mechanisms, drivers, and implications of contagion effects in financial markets. One key area of focus in the survey is the identification of the channels through which contagion spreads across countries. These channels may include financial linkages such as cross-border capital flows, trade connections, and common exposures to systemic risks. Understanding these channels is essential for gauging the potential transmission of shocks and assessing vulnerabilities within the global financial system. Additionally, the survey aims to review various empirical methodologies and models employed to measure and quantify contagion effects. These methodologies may range from traditional event studies and correlation analyses to more sophisticated econometric techniques such as vector autoregression (VAR) models, structural VAR models, and dynamic factor models. By evaluating the strengths and limitations of these approaches, the survey seeks to provide insights into best practices for identifying and analyzing contagion phenomena. Furthermore, the survey delves into the drivers of contagion, including factors such as market sentiment, investor behavior, and policy responses. Understanding the behavioral dynamics that underlie contagion events is crucial for formulating effective policy responses and mitigating systemic risks. Lastly, the survey aims to assess the implications of contagion for financial stability, economic growth, and policy coordination. By examining the real-world consequences of contagion episodes, the survey seeks to inform policymakers and market participants about the potential spillover effects of financial crises and the importance of international cooperation in addressing contagion risks.